The present invention relates to computer-based techniques for managing orders placed in a physical market for trading instruments such as stocks, bonds, stock options, futures options and futures contracts on commodities including agricultural products, financial instruments, stock market indices and the like.
A futures contract is an agreement providing for the future delivery of a fixed quantity of a commodity under conditions specified by a federally designated exchange. In general, that contract is a firm legal agreement between a buyer and seller to make or take delivery of the underlying commodity and is cleared by a separate clearinghouse.
The futures exchanges house centralized auction markets (called designated contract markets) where standardized contracts for future delivery of specified quantities of commodities are bought and sold by open outcry. The open outcry method of auction trading is widely believed to be the best method of buying and selling goods because of the fast access to the market it provides to all prospective traders. It is important to note that the exchanges themselves do not trade futures contracts, nor do they set prices at which contracts are traded. They merely furnish a place where market participants and their brokerage representatives can meet to trade futures contracts.
Trading generally takes place in a pit or around the outside of a ring. All orders received by exchange member firms are transmitted to the exchange floor for execution and are filled according to bids and offers in the respective pits by open outcry to all members present at the time. Only one instrument or commodity is traded in a pit or around a ring unless the volume is too small to justify so much space. Customarily, those trading the same contract delivery month gather in the same area of the ring or on the same step of the pit so that a broker with an order can locate the particular market as quickly as possible.
Transactions on the trading floor must be reported to the membership and the general public. This is accomplished through a variety of communications systems by the various exchanges. Transaction information is typically entered by exchange-employed market reporters in each trading pit and is accessible through computer terminals and electronic wallboards on each trading floor. At present the open outcry auction in the pit produces a large quantity of information which must be recorded accurately and quickly by hand.
At the end of each day the clearing house, which may be a subsidiary of the exchange or an independent entity, assumes one side of all open contracts: the clearing house becomes the buyer to each seller of a futures contract, and a seller to each buyer. The clearing house guarantees its members the performance of both sides of all open contracts.
Other aspects of the commodity markets are treated in the literature, which includes Kaufman, "Handbook of Futures Markets," John Wiley & Sons, New York (1984); Rothstein, "The Handbook of Financial Futures," McGraw Hill Book Company, New York (1984); Gould, "The Dow Jones-Irwin Guide to Commodities Trading," Dow Jones-Irwin, Homewood (1981); Goss & Yamey, "The Economics of Futures Trading," John Wiley & Sons (1976); Johnson & Hazen, "Commodities Regulation," Little, Brown and Company, Boston (1989); R. Teweles et al., "The Commodity Futures Game," McGraw-Hill, New York (1974); T. Hieronymus, "Economics of Futures Trading," Commodity Research Bureau, Inc., New York (1971); "Commodity Trading Manual," Chicago Board of Trade, Chicago (1989); and J. Schwager, "A Complete Guide to the Futures Markets," John Wiley & Sons, New York (1984).
Floor traders are generally classified in two ways: (1) speculators, or "locals", buy and sell for their own accounts; and (2) floor brokers fill orders for commission houses, producers and processors seeking to lock in a price for their products. Unless a trader is a member of an exchange, it is necessary for the trader to deal on the exchange through a member brokerage firm. Normally, firms that handle public business (the "commission houses") must be registered as "Futures Commission Merchants", or "FCMs." A "local" can take long-term positions (i.e., weeks or months) or "scalp" over very short periods (liquidating positions within seconds or minutes of entering the transactions). He may trade in one or more pits. He benefits from the speed with which he can take or liquidate positions, but this is in itself no assurance of a profit. Some floor traders specialize in spreads by taking opposite positions between future or options when the price difference appears abnormal. Floor traders have the advantage of lower transaction costs available to all members of exchanges.
The floor traders who execute orders for others but seldom or never trade for themselves are the brokers who may specialize in orders from customers such as commercial processors, exporters, financial institution commodity trading funds and the like. They may receive only a small percentage of the commissions paid by the customer to his commission house, but the commission revenues may be substantial depending on the volume of business. The orders held by a floor broker at any given time are referred to as his "deck." He is allowed to trade for his own account if he chooses, but he can not use the public orders to benefit his own trading.
When a registered representative of the commission house receives an order from a customer, the representative sends the order to the commission house's order desk on the trading floor, where it is usually handed to a messenger and taken directly to an appropriate broker in the trading pit or ring. Once the broker in the trading pit has the order, he typically uses voice and hand signals to announce his bid or offer price, the delivery month, and the quantity to be bought or sold. Once the order has been executed, it is carried by messenger back to the commission house's order desk on the trading floor, and the confirmation of the order is dispatched back to the office where it was initiated. The representative then usually telephones the confirmation to the customer or hands him a confirmation slip if he is present in the office.
The communication of orders from the registered representative to the order desks on the trading floor takes place with great speed. All orders are time-stamped at various stages along the order route as a check that the order is being expedited in the best possible fashion. Increasingly, this process is performed by computerized communications systems which start with a terminal used by the registered representative and end with a printer near the broker. Often the computer simultaneously records the terms of the order for later use in preparing statements for the registered representative and his customer.
The floor brokers' stock in trade is their skill in executing the orders they receive and accept. They must decide, instantly, the tactics that will be most effective in filling a given order: whether to wait for bids or offers, or whether to hold with the current price, or to bid up or offer down promptly. To be effective, they must know the pit: who will do how much at what price. They must read the intentions of scalpers, locals and other brokers while concealing their own intentions.
One of the skills of a broker is in knowing his deck. As described above, the deck is a stack of orders that are to be executed by the broker. The orders are typically written on pieces of paper about five by seven inches which are then arranged by the broker in a sequence for execution as the market price moves up or down. The broker usually folds them for concealment and puts them in his pocket so that his hands will be free to signal and to handle his trading card and pencil. Occasionally, the decks are as much as an inch thick and require great memory skill and anticipatory planning.
Perhaps the most common type of order is the "market order" in which the customer states how many contracts of a given delivery month he wishes to buy or sell. He does not specify the price at which he wants to initiate the transaction but simply wants it placed as soon as possible at the best possible price.
"Contingency orders" are those that impose certain limitations beyond the quantity and delivery month, such as limits in price or time, or both. A "price limit order" contains a price limitation that is specified by the customer; it can be executed only at the price specified or at a better price level. A "fill or kill" order contains a specified price at which the order must be executed or it is to be immediately cancelled.
"Stop orders" are sometimes confused with "limit orders", but they are actually quite different. A "buy stop order" instructs a broker to execute the order when the price of a commodity rises to a specified level above the current market price. The "buy limit order" is usually placed below the current market price and must be executed at the limit price or better. The difference between a buy limit order and a buy stop order is exemplified as follows. A customer may be inclined to buy December sugar, which could be selling at a price of 5.43 cents per pound. The customer could tell his broker to buy a contract at a price not to exceed 5.35 cents; this is a "buy limit order". Another customer under the same circumstances could tell his broker to buy a contract of December sugar but not until the price rises to at least 5.55 cents, at which point the order will be executed at the market; this is a "buy stop order". The buy stop order is placed above the current market and may be executed at the price specified on the stop, above it, or below it because it is executed at the market price after the stop price is touched; at that point, the stop is said to be "elected".
A "sell stop order" instructs a broker to execute an order when the price falls to a given level, at which point it is to be executed at the market price. Unlike a typical "sell limit order", the sell stop order is below the current market price and may be executed at a price at, above, or below the specified stop price when it is elected.
Some customers will raise their stop prices as the market price advances in an effort to gain as much as possible from a major move, while making certain that they can probably lose back only a little of the gain. Such an order is frequently called a "trailing stop".
A somewhat more complex order is the "stop limit order". The customer might instruct his broker not to buy sugar until it rises to 5.53 cents per pound and not to pay more than 5.55 cents. This is unlike the unlimited stop, which becomes a market order when the stop price has been touched. The limit price may be the same or different from the specified stop.
A "market-if-touched (M.I.T.) order" is like a limit order, but the M.I.T. order is executed at the market when the market has traded at the price specified on the order, and so it may be filled either at that specified price, above it, or below it. M.I.T. orders are sometimes called "board orders". The order may be entered for one day, a specified period, or open (i.e., good until cancelled).
Sometimes a customer may wish to take a position within a short time but would like the broker on the floor of the exchange to use some of his personal judgment in the timing of the fill. The broker could do this if the order indicates that he is to fill it at the market but is to take his time and will not be responsible if by waiting too long or not waiting long enough the price is unsatisfactory to the customer. Such orders may be marked "not held". Customers may also specify the time at which they wish their orders filled, e.g., "on opening," "on close," or at a particular specified time.
"Alternative orders" provide for one of two possible executions: a customer may order 5,000 bushels of corn at $1.45 a bushel and 5,000 bushels of wheat at $2.56 a bushel, but not want both. A far more common example of the alternative order is the placing of an objective and a stop, with instructions to cancel one if the other is filled; for example, having bought one contract of soybean oil at 14.50 cents a pound, a customer may order his broker to sell the oil either at 14.95 or 14.25 cents stop, whichever occurs first, and then immediately cancel the remainder of the order to avoid inadvertently reversing his position.
"Scale orders" are used to establish or liquidate positions as the market moves up or down. The sugar trader may instruct his broker to buy a contract of sugar at 5.45 cents and another contract each time the price drops five points from that level until he has accumulated six contracts. When he sells out his position, he may order the broker to sell one contract at 5.70 cents and another contract each time the price rises five points until his six contracts have been sold.
"Contingent orders" are filled by the broker after the price of another contract or even another commodity reaches a specified level.
"Spreads" may be established at a fixed difference rather than at specified prices because the spreader is concerned only with the difference rather than the level. He may therefore order his broker to "buy one July pork bellies and sell one February bellies at 80 points difference or more, premium February." Such an order could be used to establish a new spread position, which the trader believes will narrow, or to take the profit in a position at a narrower difference and be satisfied with the profit at 80 points difference.
Although the foregoing description has concentrated on the commodity futures markets, it will be understood that the order management system of the present invention is applicable to all markets, including those for securities trading. Securities markets are usually based on actions by specialists, each of whom is the market maker for one or more specific securities. In the New York Stock Exchange, for example, the ultimate determination of price for any given transaction frequently is determined by a specialist who deals in a particular stock and who maintains a running list or "book" of offers to sell and orders to purchase that stock. The specialist may complete a transaction in the stock whenever one or more purchase and sell orders can be matched with respect to price; on occasion, the same specialist purchases the particular stock in which he specializes or sells the same stock in order to maintain a market for the stock and prevent violent fluctuations in its price. Similar functions, particularly with respect to the matching of orders to purchase and to sell, must be carried out in all auction markets for the marketing of fungible goods, including such commodities as wheat, corn, and the like as well as stocks and bonds.
A computation system for establishing prices in auction trading for the securities market is described in U.S. Pat. No. 3,581,072 to Nymeyer. That computation system comprises a main data store for recording encoded data items representative of orders to buy and to sell the goods, such orders including orders at specific prices and other orders "at the market." The system includes a buy order sequencing device for arranging and recording purchase offers first in descending order by price and secondly by time of entry so that at each price level the oldest orders are uppermost. A sell order sequencing device is provided for arranging and recording all offers to sell first in ascending order by price and secondly in descending order by time so that once again the oldest orders are the highest at each price level. A closing price store is provided to record the last actual selling price for the goods. The closing price store and the main data store are coupled, by suitable control means, to the sequencing devices in order to transfer the recorded data items from the data store to the sequencing devices with "at market" prices being transferred at the aforementioned last selling price. The two sequencing devices are coupled to a comparator that compares the sell orders and the buy orders, when they have been arranged in sequence, to determine the lowest buy order price that is equal to or greater than a recorded sell order and thus establish a new selling price for the goods.
More than such a system for merely matching buy and sell orders, the present invention provides a system that allows brokers to manage their decks and to improve the accuracy of communications between the trading floor and the customers. The present invention can also reduce the back office costs to trading firms by reducing the volume of paperwork and consequent errors.